The key to being happy with your finances

New research from Morningstar’s behavioural research team looks into how to really achieve financial wellness.

They’ve found that objective realities like income and total wealth definitely contribute to financial wellbeing, but not as much as would think.

Financial wellbeing is split into two categories that need to be achieved to fully attain it. The first is objective, and the most obvious. It is the ability to meet current and future financial needs. The second is a little more nuanced. It is the subjective feelings of being financially secure and being able to enjoy your life. This feeling will vary from person to person, and will require different levels of the ‘objective’ goal to be achieved. For example, one person may feel financially secure holding six months of emergency savings. Another person might still think this is not enough, and want at least two years of emergency savings in the bank to have peace of mind.

This is important is because financial stress impacts many of us. It is a key determinant of our emotional wellbeing. According to the Australian Psychological Society, the number one source of stress for Australians is money. One of the leading causes of divorce is disagreements about money. It permeates into every part of your life and impacts your overall happiness.

The research is useful in providing solutions to improve financial wellbeing, and therefore overall wellbeing.

Financial wellness and financial behaviours are bidirectional

The Consumer Financial Protection Bureau (CFPB) in the US has a framework for financial wellness that believes behaviour is a precursor to financial wellbeing. For example, paying off a credit card debt is the behaviour, and financial wellness is a result.

Our researchers believe that this relationship is bidirectional. For example, you fully pay off your credit card debt and this makes you feel better about your overall financial situation. This positive feeling prompts them to continue compelling them to enact other good financial behaviours as they continue to chase that positive feeling.

Unlike every other person in financial services, I don’t run. But - I hear this is similar to a runner’s high. The great feeling that runners experience after a jaunt makes them continue to chase that feeling and continue their hobby of running. Good for them.

This is useful information to know. If financial wellbeing can be a catalyst for more good behaviours that strengthen that wellbeing, investors can focus not just on undertaking good behaviours, but taking a step back from your financial situation and understanding that you may be in an objectively better position than you think you are. More on this later – but the research shows that those with higher asset levels have a higher rate of failing the ‘subjective’ financial wellbeing threshold.

The solution: Increasing your emergency fund

The study examines a particular relationship to solve for this issue. They look at how current subjective financial wellness relates to emergency savings behaviour.

Emergency funds protect individuals against financial shocks. It is fundamental to financial wellness, and to good investing behaviour. Despite this, the study finds that many people struggle to build up an emergency fund.

Building up an adequate emergency fund can give people the confidence that they need to feel more capable and comfortable for planning for the future. This can start the positive feedback loop that build on financial wellness.

In the study, only 41% had a fully funded emergency fund. Adding to this, those who did not have an emergency fund had very little progress towards an emergency fund. Most had not reached half their target, and 25% had no emergency savings at all.

The likelihood of having fully funded emergency fund was linked to both objective and subjective financial wellness—those who felt dissatisfied with their finances were less likely to have good emergency-savings behaviour, and this effect was larger when a person had lower amounts of investable assets.

However, subjective financial wellness was not always achieved, even by those with the highest investable asset base (more than $349,000 USD). They reported feeling financially dissatisfied. 30% of them had failed to reach emergency-savings adequacy.

Emergency savings are critical for financial wellness – both objective and subjective. It is easy for individuals to ignore, but it is so critical that it impacts overall wellbeing. Achieving adequate emergency savings can also create a ripple effect with the feedback loop that our researchers mentioned, allowing you to have the dopamine hit that reinforces good behaviour.

Key takeaways for investors

Financial wellbeing isn’t just about how much you earn or how much you have in investable assets. Part of financial wellbeing is subjective. It is easy for investors to follow industry standards such as ‘3-6 months of emergency funds’, but this is only a rule of thumb.

We reiterate over and over again that personal finance is just that – it is personal. Objectively, 3-6 months of emergency funds may be enough, but does it give you the peace of mind that you need? This will depend on you, your circumstances and your prior experiences.

Even some of our wealthiest participants (those with more than $349k in investable assets) reported feeling dissatisfied with their finances. This echoes previous research that finds objective financial wellness metrics, like income and wealth, are only part of what leads to feelings of financial wellness and are not the whole story.

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